Chinese banks face tough balancing act of keeping profits, buoying economy

Smaller banks face being left in weaker financial positions, Natixis warns.

Chinese banks may need to sacrifice their profitability, and lower lending costs to help companies and households in order to support the country’s economy, Natixis Global Markets Research said in a media note.

China’s economic model meant that the banking sector plays a key role in supporting fiscal stimulus, especially in the government-led infrastructure spending and keeping companies afloat, according to Natixis’s chief economist Asia Pacific Alicia Garcia Herrero. 

“As the Chinese government urges banks to support economic growth after the zero-Covid related lockdowns, the trade-off between profitability and mandate to support the recovery will become increasingly apparent,” Garcia Herrero said.

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Garcia Herrero named two challenges that China-based banks face: worsening asset quality due to the zero COVID policy, and an environment that makes it harder–especially for smaller banks–to raise much-needed capital.

“Finally, China has made some progress in the financial opening but is very concentrated on lifers. There is still a long way to go for the rest, especially for banks. As such, the lifeboat from increased foreign participation in the banking system seems highly unlikely for now,” she added.

Smaller banks will particularly fall to a weaker financial stability position.

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“As the government pushes harder to revive the economy, small banks have already seen pressure on lower NIM. With greater exposure to real estate and small and medium enterprises (SMEs), small banks may also see a deterioration in asset quality and solvency at the current juncture,” Garcia Herrero said. 

As of Q1 2022, the decline in bad loan ratio is now more limited, and there is a worsening trend in city commercial banks, she warned, adding that said, the divergence between large and small banks can widen further in NIM and asset growth, leading to more pressure on capital.

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“China's banking sector is generally an important driver of the government stimulus but with increasingly less room for help due to waning profitability, especially from smaller banks. Whilst Chinese banks are supported by faster asset growth and improved asset quality, the NIM has decreased for years. For quite some time, non-interest income helped support profitability, but this is no longer the case with higher costs,” Garcia Herrero said.